Analysts have been bullish over the Rolls-Royce Holdings (LSE: RR.) share price as it’s soared 1,180% over the past five years. No sooner does it approach their target price than they raise it a good bit higher.
But their bullishness appears to be slowing. The average price target now stands at 1,095p, just 3% ahead of the current price. Considering there’s a strong Buy consensus, with only one out of 16 analysts rating Rolls a Sell, that doesn’t seem too ambitious.
There’s always one party pooper, isn’t there? But the lone bearish stance looks like something of an outlier.
Massive crash ahead?
The lowest price target of the range is down at a measly 240p. That would mean a 77% crash from the current Rolls-Royce share price. Has this broker not been paying attention to Rolls-Royce’s stream of expectations-busting results?
The downbeat prediction comes from Berenberg and dates all the way back to January 2024. At the time, the German bank said “We see the risk/reward in the commercial aerospace division as unfavourable“. That might seem like a short-term mistake, but Berenberg was looking beyond 2027 and to the longer-term risks it sees.
When it comes to statistics, one common approach to trying to render an average more representative is to eliminate outliers. If my memory of how to do this is good, I reckon removing that one would push the average price target to 1,152p — 8.5% above today’s price.
Valuation
Forecasts put the Rolls headline price-to-earnings (P/E) ratio at 42.7 for the end of 2025. They’d drop it to 30.4 by 2027, but even that seems perhaps a bit rich.
But a headline P/E doesn’t account for any debt or cash a company might hold. If we have two similar companies with the same stated P/E, but one has billions in net debt and the other has net cash… well, it would hint at which was the better value. Rolls is forecast to end this year with next cash of £2bn, climbing to $7bn by 2027. And that should make the valuation more attractive than the headline suggests.
Instead of the P/E, we can compare the enterprise value (EV) of a company (which adjusts the market cap to allow for net cash or debt). And we can compare that to its forecast EBITDA — a measure of total earnings.
EV/EBITDA forecasts put the Rolls-Royce ratio at 21 for this year, dropping under 17 by 2027. On that measure, Rolls is valued 50% above aerospace sector fellow BAE Systems for this year. On a P/E basis, it’s 70% ahead.
Worth its premium?
Rolls-Royce still commands a premium over BAE. But perhaps not as wide as the P/E alone might suggest. And with Rolls’ prospects for its nuclear-powered small modular reactors accounting for a chunk of its future valuation, the premium might be justified.
So what’s my bottom line? Even Rolls’ adjusted price target and the EV/EBITDA ratio still make the stock a bit too rich for my relatively risk-averse approach. But I intend to consider both if we see any future price dips.
